Asset Management Approaches for Retirement Income Don’t Work for the Middle Market

The financial planning industry is not ready to help the middle market make informed retirement decisions when they need it most.

In my April, 2013 article in the Journal of Financial Planning (Still MIA: Comprehensive Best Practices for the Mid-Market), I referred to a recent study by the Society of Actuaries (SOA), “The Impact of Running Out of Money in Retirement”i , which concluded that “running out of money is too large of a risk to self insure.” The point of the article is that today’s commonly used asset management-focused approaches fall far short of meeting the needs of the middle market because they implicitly assume the individual can afford to self-insure their retirement risks.

This follow-up article highlights another recent SOA paper, Middle Market Retirement: Approaches for Retirees and Near-Retireesii. It spells out the strategies or models most used today by individuals, professionals and other service providers, and evaluates how well they meet the retirement income and risk management planning needs of the middle market.

Characteristics of the Middle Market

2009 SOA-sponsored research by Millimaniii defined the middle retirement market in the U.S. as representing approximately 12 million households (11% of all households) headed by people ages 50 to 75 years old who are either approaching or currently in retirement and have a net worth between $50,000 and $1,000,000. It excludes the 25% of this age group with less income/assets and the 15% with more.

Other research concludes that the planning approaches to use for middle market couples and singles are different what would be used for their wealthier peers of same age and/or gender.

They have significantly less investable assets (their largest asset are their Social Security benefits and home equity)

Being resource constrained limits their options for income and risk management options

They are less inclined and able to pay for advice, and are less trusting of advisors and financial institutions.

Income planning is focused primarily on cash flow and debt versus investing

They have to make trade-off decisions to get the most bang for their buck in lifestyle and healthcare options

An efficient process is key to being productive and profitable in serving this market. Asset under management models do not serve their needs.

A Summary of Models Applied Today

Most of today’s retirement income strategies or models focus on how to manage investable assets to provide a retirement income stream with a high probability of lasting at least thirty years. For most people in the mid-market, their largest financial assets (in order of financial value) are the present value of their future Social Security and/or pension benefits, their home equity, and then their IRA and/or defined contribution savings.iv Only the last of these assets are potentially “manageable” over time by financial professionals, and in most cases it has the least value of the three. In sum, most of today’s asset-oriented, “best practices” retirement income models aren’t designed to address the retirement income and risks management needs of mid-market.

According to the SOA’s Middle Market Retirement whitepaper, the retirement analysis/advice models commonly used today can be categorized as follows:

Asset management models that focus almost exclusively on retirement asset value targets, where the investment objective is to meet income and growth and/or legacy intentions. Other retirement risks are minimally considered. Sub-categories include:

Pure asset allocation models.

Asset allocation models (i.e., Monte Carlo modeling) which are accumulation models adapted to provide retirement income (the approach used by most securities firms today).

Bucket strategies, where assets are divided and managed according to an identified risk profile and time period for anticipated withdrawals.

Asset liquidation models which consider tax and other characteristics to arrive at a distribution plan.

Target date funds where assets are managed according to a common risk profile.

And the most popular of all, “rules of thumb” models such as the 4% rule, or the “invest conservatively and live off the interest” rule.

Income and cash-flow models that focus on producing a smooth, sustainable income stream that preserves income and asset values. Financial-product focused, this approach generally provides little consideration of other retirement risks or life circumstances. Sub-categories include:

Necessary vs. discretionary expense models that are geared to securing lifetime income sources for necessary expenses and use of riskier investments for discretionary expenses.

Cash flow models that take into account expenses and multiple income sources.

Holistic Models that evaluate a host of risks and decisions together, including lifestyle decisions as well as those that are non-financial, in order to provide a financially-sound life plan. Sub-categories include:

Multi-disciplinary models that provide an evaluation of the whole person or entire family and that make both financial and non-financial recommendations. Sophisticated software versions do not exist today for this model; however there are some consumer or professional software packages which holistically provide guidance for individuals in the second half of life.

How to Evaluate Today’s Strategies for Use with the Middle Market

The centerpiece of this whitepaper is a chart that compares the above models to what your mid-market clients need you to do for them. It states whether the model includes, usually includes, sometime includes, usually doesn’t include or doesn’t include addressing the characteristic from the perspective of the mid-market. I highly recommend reviewing the complete version of this summary of Table 2 that begins on page 7 of the report, where you’ll get a clearer picture of how well the models apply to different market segments. In sum, the asset management models most used today don’t include what we should be evaluating to help middle market clients make informed decisions.

A comparison of today’s retirement analysis/advice modeling approaches: How well does the model analyze…

So Which Models Are Best for the Middle Market?

The most effective retirement analysis/advice approaches in practice today for use with the mid-market are the income and cash flow, risk management, and holistic models (in sum, not the asset management models). However, new and improved approaches and products are still needed. The market segment each approach is most appropriate for is bolded.

Type of Approach

Best applied to

1. Asset Management Models

a. Pure asset allocation models

High net worth households

Pre-retirement savings

Managment of lump sums received

b. Asset allocation/retirement income models

High net worth households

Households that have other risks already covered

Managment of lump sums received

c. Bucket strategies

Households with significant investible assets

Households with high risk tolerance

Single individuals or couples with similar life expectancies and spending patterns

d. Asset liquidation models

High net worth households

Inherited assets

Assets with low liquidity

e. Target date funds

Pre-retirement savings

People with no knowledge of investments

People who can afford not to optimize their own portfolio

a. Rules of thumb

Households with significant investible assets

Households that have other risks already covered

People who can afford not to optimize their cash flow management strategy

2. Income and Cash Flow Models

a. “Necessary vs. Discretionary” expense models

People living alone

Other non-complex financial situations

Middle income retirees

b. Cash flow models

Middle income retirees

Households with simple or moderately complex cash flows

Households with coverage for other risks

Risk Management Models

Integrated models

High-middle income households

Near-retirees and early retirees

People with unusually large or complex risks

Step-wise models

Middle income households

Near retirees and early retirees

People with moderately complex risks

Non-Integrated models

Upper-middle income households,which can afford not-optimal combinations of decisions

People with few, small or non-complex risks, or who already have the principal risks covered

Retirement Planning Software Opportunities and Solutions

Ways for consumers to store documents and personal information for self-service that helps reduce costs of servicing them

The ability for consumers to enter their own data for professionals to confirm and use in planning, with adequate quality control to minimize errors

The ability for consumers and advisors to model trade-offs.

More is Needed

Most retirement income planning today is adapted from models used to accumulate assets. These approaches are not relevant to the needs of people with few manageable assets who need to make critical decisions regarding timing of retirement and risk management.

There are also still many gaps and problems with the software available to planners for use with the mid-market. Retirement income planning and risk management needs to be holistic so that it incorporates cash flow, assets that don’t need to be managed over time, risk management and life choices. Most planning resources today only address subsets of these approaches.

In sum, planners don’t have the comprehensive resources and planning tools which we need today to properly serve this market. We could sure use the help of the academic community in developing new approaches, products, software improvements and retirement plan design ideas.

Please consider sharing this article if it will help those you know help increase the retirement preparedness of their clients/employees!

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